Drillingcontractor.org-Offshore Optimism for an Uncertain FuturenbspnbspDrilling Contractor

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http://w ww .drillingcontractor.org/offshore-optimism-for-an-uncertain-future-9259 July 6, 2011

Offshore, optimism for an uncertain future | DrillingContractor

Even without long-term contracts, contractors rushing to order new rigs in large quantities

By Tom Kellock, ODS-Petrodata

Figure 1: Jackups remain the leading type of rigsbeing ordered or planned in new offshore rigprojects even though less than 65% of the existingjackup fleet is at work. Overall for all rig types, 72new rigs projects have been announced since mid-2010; there are also options for 51 additional newrigs.

The last time I had the privilege of writing an article

for Drilling Contractor was in March 2009, when theoffshore drilling industry was reeling from the effectsof the more than 70% drop in oil prices in less than ayear. Today, while oil prices have recovered,

although they are still considerably below the level seen in July 2008, there is still a host ofunresolved issues facing both contractors and operators.

First and foremost is Where are oil and gas prices going next? Most observers feel that currenttroubles in North Africa and the Middle East, sparked by Tunisias revolution, are keeping priceshigher than they would otherwise be. However, Japans reduction in energy demand due to idledrefineries and factories must presumably be having a negative effect on prices, although by how

much is not clear.

Longer term, the virtually inevitable slowing of nuclear power development in the United States andprobably other countries, following the damage caused to a number of Japanese nuclear reactorsby the March earthquake and tsunami, will almost certainly lead to increased oil and gas demand.This will be supportive of higher prices.

For US natural gas prices, the key issue is whether shale gas development will survive theenvironmental challenge it is now facing.

Meanwhile, the rest of the world is only in the very early stages of large-scale shale gas

development, but these could conceivably lead to massive new supplies at a cost that makesoffshore production an uneconomic proposition as appears to have already happened in theUnited States, where jackup demand was declining rapidly even before the slowdown in the issuingof permits following the Macondo incident.

More immediately, the eagerly awaited first post-Macondo permits for deepwater drilling in the USGulf are being issued but, as yet, with no assurance that these will come in a sufficiently steady flowto justify operators chartering rigs on a long-term basis for use in the region; any significant amountof downtime between wells would be prohibitively expensive. Meanwhile the longer-term impact ofMacondo on equipment specifications and additional regulation in both the United States and therest of the world is still by no means clear.

Interestingly, the reaction of many drilling contractors, both large and small, to this situation is to rushout and order new rigs in large quantities. Since the middle of 2010, no less than 72 new rigprojects have been announced, and these involve options for 50 additional rigs, although there is noguarantee that many of the latter, let alone a majority, will be converted into firm orders.
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The stated rationales for this new building boom vary with the rig type. For jackups, three reasonsfor building new rigs at a time when less than 65% of the existing fleet is at work are commonlygiven:

1. Most of the existing jackups are old and need to be replaced.

2. The work being done by jackups is technically more demanding and requires modern high-specification units.

3. Operators want new rigs for reasons of safety and efficiency even when older rigs could do thework.

There is certainly some truth in each of these statements, but at the same time they are to someextent misleading.

Most of the existing jackups are old. With 202 jackups 30 years or older, there are certainly alot of old rigs in the fleet. However, the average age of todays rigs is 24, just under what wasprobably their original design life, and several 40-year-old rigs are working.

and need to be replaced It should be pointed out that age by itself does not necessarily tellyou very much; many of these older rigs have gone through major refurbishment and life-extensionprojects. Given the costs involved, their owners clearly did not feel that these rigs needed to bereplaced.

The work being done by jackups is technically more demanding and requires modern high-specification units While there is no doubt that this is the case for some work today, it is notalways applicable. There has been very little change in the average water depth in which jackupshave been working over the past 10 years, and today few of these rigs are working in water depthsgreater than 300 ft. When it comes to drilling capability, it is perhaps significant that a 2008extended-reach well, whose measured depth was a record-setting 40,320 ft, was drilled by a rig

built in 1981.

Operators want new rigs for reasons of safety and efficiency even when older rigs could do thework This has some validity but, at the same time, is clearly not true for all operators, who aretoday using more than 100 jackups 30 years old or older.

Figure 2: The demand for jackups has beeninsensitive to changes in oil prices over the pastdecade. Even if oil prices remain at current levels, itis unlikely that there will be a large increase injackup demand.

The newer, higher-specification jackups areenjoying higher utilization and dayrates than theirmore lowly brethren, but it may be rash to assumethat there is unlimited scope for additional units tobe added to the fleet without affecting one or both ofthese parameters. Given the length of time that

water depths of less than 400 ft have been accessible for drilling, most prospective areas are fairlymature. With overall demand for jackups remarkably insensitive to changes in oil prices over the lastdecade, it appears unlikely that there will be any great increase from todays even if oil prices stayat current levels.

The arguments listed above supporting the need for newer and more powerful jackups could beapplied equally well to the mid-water floater fleet, which on average is actually older than the jackupfleet, primarily because it has not seen an influx of new rigs in the past decade.


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However, with the exception of a handful of new rigs aimed at the harsh-environment markets ofNorway and the Barents Sea, almost all contractors are ignoring this segment and, as far as floatersare concerned, are concentrating entirely on ultra-deepwater units. All of the recent orders andoptions are for rigs with a rated water depth of 10,000 ft or more.

To justify the construction of these rigs, most of which other than the seven drillships forPetrobras are being ordered on a speculative basis, two arguments are being put forward.

1. These rigs are available at prices that will probably never be repeated.2. The deepwater market is where the growth in rig demand will come.

It is hard to argue with either statement. As this article was being written, Maersk Drillingjustannounced that it expected to pay approximately US$650 million for each of two 12,000-ft waterdepth drillships from Samsung, including owner-furnished equipment, project management,commissioning, startup costs and capitalized interest, i.e. everything except the cost of mobilizationto the first drilling location.

This compares to almost $1 billion being paid for at least one (non-harsh environment) ultra-

deepwater semisubmersible ordered in 2008.Figure 3: Despite increases in the water depths atwhich floaters are operating, the average workingwater depth for floaters is still only around 3,000 ft.

With regard to growth in demand for these rigs,there is little doubt that, if current trends in terms ofdiscoveries continue and oil prices do not fall belowUS$75/bbl for any extended length of time, manymore rigs will indeed be needed. Whether they all

need to be capable of drilling in 10,000 ft or even12,000 ft of water is, however, much moredebatable.

While the trend in floater use has seen a fairly steady rate of increase over the years, the averagewater depth in which floaters are currently drilling is only around 3,000 ft.

For the ultra-deepwater rigs, defined here as those equipped for work in water depths greater than7,500 ft, the average well water depth has remained fairly constant over the past 10 years at a littlemore than 5,000 ft. Of course the number of rigs in this category has increased substantially overthis period, from 17 in 2001 to 81 in April 2011, so the volume of drilling in deepwater has also

increased greatly, but we are still a long way from needing many rigs to drill in more than 10,000 ft ofwater.

In summary, we are seeing a dynamic market with a shift in the nature of some jackup drilling,although overall demand in this segment remains fairly flat, little expected change in the use of themidwater fleet, and growing demand for deepwater rigs but perhaps not for ultra-deepwater units.

Operators should be thanking their lucky stars that drilling contractors are taking steps today toensure that there will be enough rigs, perhaps more than enough, with the appropriate capabilitiesto meet their demands in the future, by ordering rigs today without, in most cases, the security of along-term contract. Hopefully they, and the organizations involved in the financing of these units, will

be well rewarded for this strategy, but undoubtedly there will be some surprises in store in the yearsto come.

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